Sallie Mae Sues to Force A Buyout

By ANDREW ROSS SORKIN and MICHAEL J. de la MERCED

Published: October 9, 2007

The SLM Corporation, parent of the student lender Sallie Mae, filed a lawsuit yesterday against a group of firms that had agreed to buy it for $25 billion but now are trying to renegotiate the deal.

The suit, filed last night in Delaware Chancery Court, comes one day ahead of a self-imposed deadline by the buyers to reach a new agreement. Failing that, the buyers -- the private equity firms J. C. Flowers & Company and Friedman Fleischer & Lowe and the banks JPMorgan Chase and Bank of America -- were prepared to walk away. Under the terms of the deal negotiated in April, the firms would pay a $900 million breakup fee.

The lawsuit is the harshest turn yet in one of the most bitter buyout fights this year. Buyers in other deals have clashed privately with their targets over price and terms of the acquisitions, but Sallie Mae and its suitors have been unafraid to slug it out in public.

At the heart of the dispute is whether Sallie Mae is worse off financially than when the deal was reached in April. The buyers have said that recent legislation reducing subsidies to student lenders has adversely affected Sallie Mae's earnings. The company disagrees, saying the legislation's effect is too small to qualify as a ''material adverse effect,'' a legal mechanism in the deal agreement that would allow the buyers to walk away without penalty.

In its complaint, Sallie Mae argues that in its 2007 annual report, it disclosed all potential legislation that could materially affect its finances, including bills that were worse than what ultimately was passed.

''As a matter of logic and clear contractual language, legislation that is only marginally worse for Sallie Mae than the disclosed proposals'' cannot be a material adverse effect, the company said in its complaint. ''The differential effect of enacted legislation as compared to the disclosed proposals must itself be material to Sallie Mae's financial condition, business or results of operations.''

Sallie Mae's chairman, Albert L. Lord, said in a statement yesterday: ''We regret bringing this suit. Sallie Mae has honored its obligations under the merger agreement. We ask only that the buying group do the same. We are prepared to execute the contract the parties signed in April.''

In a statement, the buying group said: ''The lawsuit filed by Sallie Mae rests on a fundamental misunderstanding of the terms of our contract, and is without merit. This is a dispute that should be resolved in the boardroom, not the courtroom.''

The buyers' group threw down the latest gauntlet last week by announcing a creative compromise. The buyers offered $50 a share in cash for Sallie Mae, well below the $60 a share they agreed to pay in April. But they added a sweetener in the form of warrants to buy Sallie Mae shares, which they said could eventually be worth as much as $10 a share if Sallie Mae prospered.

Viewed one way, the cash-and-warrants combination was a clever way to tie Sallie Mae's sale price to its business prospects. Viewed another way, it is was an attempt to get Sallie Mae at a substantial discount while claiming to stand by the previous bid.

Sallie Mae has consistently rejected those efforts, however, and has insisted in holding its buyers to the terms of the original contract.

According to the investor group's analysis, the proposed warrants would be worth more than $7 a share if the company ''performs consistent with its own projections.'' They could be worth as much as $10 a share if the company tops its projections, the investor group said.

However, because they are not exercisable for five years, the warrants are probably worth closer to $4 to $5 a share at most.